Ethereum’s biggest ever upgrade took effect, in what industry experts are calling a game changer for the entire crypto sector. So far, all signs point to the so-called merger – which is designed to cut the cryptocurrency’s energy consumption by more than 99% – being a success.
The very first proof-of-stake block of transactions has completed with a near 100% client participation rate. This was arguably the best case scenario.
The overhaul of the ethereum network fundamentally changes the way the blockchain secures the network and verifies transactions. Most of these changes happen under the hood and the mark of a successful upgrade is if the end user does not feel a difference in the hours and days ahead.
Cryptocurrencies such as ethereum and bitcoin are often criticized for the process of mining to generate new coins. Before the merger, both blockchains had their own vast network of miners across the planet running highly specialized computers that crunched mathematical equations to validate transactions. It’s called proof-of-work, uses a lot of energy and is one of the industry’s biggest targets for criticism.
But with the upgrade, ethereum has migrated to a system known as proof-of-stake, which replaces miners with validators. Instead of running large banks of computers, validators leverage their existing cache of ether as a means of verifying transactions and creating new tokens. This requires far less electricity than mining and experts say it will make the protocol both safer and more sustainable.
Ether is trading at around $1,610, down more than 1.5% in the last 24 hours.
Nine teams and more than 100 developers worked on the merger for years. In the hours ahead, this decentralized network of programmers spread across the planet will monitor the rollout and, if necessary, troubleshoot as quickly as possible.
Danny Ryan, a core developer based in Denver who has worked on the merger for five years, tells CNBC that they will look for any irregularities via both automated and manual monitoring systems. If any issues arise, the corresponding team will troubleshoot and release an update to users, but Ryan says they’re pretty confident going into the merge given all the successful dry runs in recent months.
“It can be kind of a small fire that gets put out very quickly,” Ryan said. “But the network as a whole – because of the redundancy across all this different software – will very likely be stable and fine.”
Part of why the merger is such a big deal has to do with optics.
Last week, the White House released a report warning that proof-of-work mining could get in the way of efforts to curb climate change. Cutting energy consumption by approximately 99.95% will not only establish greater sustainability for the network, but will also go a long way in reducing the barrier to entry for institutional investors, who struggled with the optics of contributing to the climate crisis.
Bank of America said in a note on September 9 that the significant reduction in energy consumption after merging “may enable some institutional investors to purchase tokens that were previously prohibited from purchasing tokens running on blockchains that utilize proof of work (PoW) consensus mechanisms.”
Analysts have said that institutional money entering the digital asset space at scale is critical to its future as an asset class.
The upgrade also changes the tokenomics around ethereum’s native coin, ether.
“Ether itself becomes a productive resource,” Ryan said. “It’s not something you might just speculate on, but it’s something that can make money.”
In this post-merger era, ether takes on some of the characteristics typical of a traditional financial asset, such as a certificate of deposit, which pays interest to its owners.
“It’s probably the lowest risk return inside the ethereum ecosystem,” explained Ryan, who added that returns in other corners of decentralized finance, or DeFi, involve taking on smart contract risk and other types of counterparty risk.
The upgrade will also result in a significantly reduced supply of ether tokens in circulation, which could pave the way for ether to become a deflationary currency in the weeks and months ahead. Some investors say this could also help boost the price of the token.
The reduced supply is the result of the new verification model that replaces miners with “validators”. The reward for validators is much less than those that went to proof-of-work miners, meaning less ether will be minted as a result of this upgrade. Validators are also required to lock their tokens for an extended period, pulling ether out of circulation.
Additionally, as part of an upgrade that took effect in August 2021, the network is already in the process of “burning,” or permanently destroying, a portion of the digital currency that would otherwise be recycled back into circulation.
Developers say improved network security is another critical feature of the upgrade.
“There are changes in the security guarantees of the chain,” said Sean Anderson of Sigma Prime.
Take a 51% attack, where someone or a consortium of people controls 51% or more of a cryptocurrency, and then weaponizes that control to make changes to the blockchain.
Anderson says it is much easier to recover from a 51% attack on a proof-of-stake network because there are built-in mechanisms to financially punish malicious actors by reducing their stake.
“Because the financial resource is inside the protocol, you get much better recovery mode, so you end up with a better kind of security profile,” Ryan told CNBC.
In the next few hours, the days are the key
The next few hours and days will be key to gauge the health of the ethereum network after the upgrade. Behind the scenes, developers will monitor metrics like the participation rate of validators to determine how things are going. But coders tell CNBC that in an ideal world, users would be completely unaware of the upgrade.
“If everything goes perfectly, as an end user, you won’t notice any difference,” Anderson said. “If someone trying to trade ethereum doesn’t get it, then it was smooth sailing.”
The upgrade does not immediately make ethereum faster, cheaper or more scalable. But these features come with future upgrades that are now possible after merging.
Scalability, in particular, is something Ryan says is desperately needed for the network going forward.
Currently, layer two technologies such as sharding and roll-ups are working to solve just this.
“More scalability, more ability to process user transactions is coming online in parallel through layer two constructs called roll-ups, but the scale is not enhanced in the core protocol itself,” Ryan continued. It will come in subsequent upgrades instead.
Katie Talati, head of research at asset management firm Arca, says her team is keeping a close eye on everything in the tier two space, especially the projects that try to offer scalability.
“The biggest problem right now is that it’s very fragmented,” Talati said. “You end up with these people who are now on ethereum, but they’re ripped apart, because L2s don’t necessarily talk to each other very easily. And so it’s just not a seamless experience,” she said.